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Planning Perspective – Roth IRAs Can Work for Older Workers Too

Roth IRAs were introduced in 1998, named after their chief legislative sponsor, Senator William Roth of Delaware. Senator Roth succeeded in pushing through one of the best saving opportunities for U.S. citizens in a long time. What is the advantage of the Roth IRA? Roth IRAs allow investors to accumulate tax-deferred earnings and not pay any taxes on withdrawals. How are Roth IRAs different from traditional IRAs? Both types of IRAs allow for the accumulation of tax-deferred earnings. That is, capital gains, dividends, and interest within the account are not taxed. They differ in their treatment of contributions and withdrawals. Traditional IRAs allow for certain tax-deductible contributions while Roth IRAs do not. Withdrawals, on the other hand, are limited under traditional IRAs and subject to income tax. Withdrawals under Roth IRAs have fewer restrictions and are not subject to income tax. Aren’t Roth IRAs just for young workers? Conventional wisdom has been that Roth IRAs are just for young workers in low tax brackets (because they’re willing to pay a tax on their contribution when they’re in a relatively low tax bracket in exchange for a tax-exempt withdrawal when they are presumably in a higher tax bracket) or those ineligible for traditional IRAs. However, more and more retirees and near-retirees are receiving great savings and tax reduction opportunities from Roth IRAs every day. The key is if you have taxable wage income (i.e., compensation earned from services, not pensions), you are potentially a good candidate for a Roth IRA no matter what your age. Why would someone who is retired have taxable wage income? As we are all living longer, many of us are deciding to work past traditional retirement ages – some doing so full-time, some part-time. Those who have retired from their traditional employment may choose to stay active by making a business out of their hobby or taking on new challenges in a less stressful work environment. Can’t retirees and near-retirees use traditional IRAs? The problem with traditional IRAs is that retirees with freelance income can’t make contributions if they’re over 70 ½ years of age. Partially retired (part-time) workers may also be over the 70 ½ age limit or may not benefit much from the tax deductible feature of contributions because their part-time work will probably put them in a low tax bracket. Near-retirees (still full-time) participating in a 401(k) or 403(b) are often not allowed to make contributions into traditional IRAs. Roth IRAs do not have these contribution restrictions based on age or 401(k)/403(b) membership, making them viable options for retirees and near-retirees. So how can they take advantage of Roth IRAs? Each of these individuals can make Roth IRA contributions ($5,000 per year per person increasing to $6,000 next year) and benefit from the following:

  • tax-deferred growth forever and no taxes on withdrawals

  • passing wealth on to heirs tax-free and extending tax-deferred growth into the grandchildren’s generation

  • shifting savings from a taxable account to a Roth IRA – even if they aren’t adding to savings (ie. they spend all of their income), the presence of income allows one to move existing savings over into a Roth IRA, and

  • avoiding high taxes if the government eventually raises tax rates

As appropriate as Roth IRAs are in many cases, they are by no means appropriate in every case. Each individual’s situation must be reviewed to determine the appropriateness of its use. There is no question, however, that there are many retirees and near-retirees who are not currently taking advantage of Roth IRAs who could benefit from aggressively funding Roth IRA accounts.

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